Investors size a fund from the team's record, not from the manager's ambition. Three tests give the range the arithmetic allows.
Size a real estate fund from three tests: what the team can deploy in the investment period, grossed up for called fees, expenses and reserves; the smallest fund in which the largest target deal stays inside the concentration limit; and the fund at which fees cover the management company. On an illustrative value-add strategy those give a ceiling of 301.7 million and floors of 200.0 and 260.0 million, so a 300 million target fits. Raising 500 million on the same team leaves 40 per cent of the investable capital undeployed when the investment period ends.
Worked in full in Raising a Real Estate Fund by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
First-time and emerging managers tend to set the target from the other end: what they think the market will give them, or what makes the management company look established. Investors test it the other way round. They ask how many deals the team has closed a year, at what equity size, and whether the target implies a pace the track record has never shown. A fund size that the arithmetic supports is easier to defend in every first meeting than one that the ambition supports.
| Input | Value |
|---|---|
| Deals the team can close a year, from its record | 5 |
| Average equity cheque per deal | 18.0 |
| Largest deal in the target pipeline, equity | 30.0 |
| Investment period, years | 3 |
| Single-asset concentration limit | 15% |
| Management fee on commitments in the investment period | 1.5% |
| Fund expenses and organisational costs, of commitments | 1.0% |
| Reserve for follow-on capex and contingencies | 5.0% |
| Management company running cost, a year | 3.9 |
Ceiling = deals a year × average cheque × investment period ÷ investable share
Investable share = 1 − fees called in the investment period − expenses − reserve
In Excel: =Deals*Cheque*IP/(1-Fee*IP-Expenses-Reserve). Fees in the investment period are charged on commitments and called from investors, so they consume commitments that will never be invested.
Five deals a year at 18.0 million for three years is 15 deals and 270.0 million of equity. Fees of 1.5 per cent for three years take 4.5 per cent of commitments, expenses 1.0 and the reserve 5.0, leaving 89.5 per cent investable. 270.0 divided by 0.895 is a ceiling of 301.7 million: above that, the team cannot invest the money in the time it has promised.
Floor = largest target deal ÷ concentration limit = 30.0 ÷ 15% = 200.0
Below 200.0 million the fund cannot make its largest pipeline deal without breaching its own limit, or it has to drop the deal or syndicate it. Investors read a pipeline full of deals the fund is too small to hold as a sign the strategy and the size were set separately.
At 1.5 per cent, fees of 3.9 million a year need commitments of 260.0 million. Below that the partners subsidise the firm out of their own pockets for the life of the fund. The mechanics of that gap at a first close are worked in does a first close cover the management company's costs; for sizing, the full-fund figure is the floor.
| Line | Millions |
|---|---|
| Fees called in the investment period, 4.5% | 13.5 |
| Expenses, 1.0% | 3.0 |
| Reserve, 5.0% | 15.0 |
| Investable equity | 268.5 |
| Maximum single deal at 15% | 45.0 |
| Largest pipeline deal as a share of the fund | 10.0% |
The range the arithmetic allows is 260.0 to 301.7 million, and 300 million sits just inside the ceiling: 268.5 million to invest, which is 14.9 deals at the average cheque, against the 15 the team can do. The fund is sized to the team's record, not beyond it.
| Deals a year | Cheque 12 | Cheque 18 | Cheque 25 |
|---|---|---|---|
| 4 | 160.9 | 241.3 | 335.2 |
| 5 | 201.1 | 301.7 | 419.0 |
| 6 | 241.3 | 362.0 | 502.8 |
Each additional deal a year at an 18.0 million cheque is worth about 60 million of fund size. Pace and cheque size move the ceiling in exactly the same proportion, because the ceiling is their product: 20 per cent more deals or a 20 per cent larger cheque each add 20 per cent. But the cheque also moves the floor: a strategy whose largest deal is 45 million needs a fund of at least 300.0 million to hold it, against 133.3 million if the largest is 20 million.
The common mistake is to set the target first. A 500 million fund on this team has 447.5 million to invest at 90.0 million a year, which takes 5.0 years against a three-year investment period. At the end of the period 177.5 million, 40 per cent of the investable capital, is still undeployed. Meanwhile fees on commitments over the investment period come to 22.5 million, 8.3 for every 100 actually deployed, against 5.0 at 300 million. Investors will see the pace in the track record and ask which of the two the manager is planning to do: stretch the investment period or lower the bar on deals.
The right fund size is the overlap of three numbers: the deployment ceiling, the concentration floor and the management company floor. Here that is 260.0 to 301.7 million, and a 300 million target is the one a reviewer can rebuild from the record. How that target arrives on a calendar, and why a first close at a quarter of it does not cover the firm, is in the free workbook for this case; whether a 2 per cent placement fee is worth paying covers the cost of reaching it faster.
They divide the investable part of the target by the pace and cheque size the team has shown. Illustratively, a team closing five deals a year at 18.0 million can deploy 270.0 million in three years, which supports about 301.7 million of commitments once fees, expenses and a reserve take 10.5 per cent. A larger target implies a pace the record does not show.
It sets a floor: the fund must be large enough that its biggest intended deal stays inside the limit. With a 15 per cent single-asset limit, a 30.0 million deal needs at least 200.0 million of commitments, and a 45.0 million deal needs 300.0 million.
Capital stays undeployed when the investment period ends and fees on commitments rise per unit invested. In the illustration a 500 million fund on a 90.0 million a year pace takes 5.0 years to invest, leaves 177.5 million undeployed at year three and pays 8.3 of fees per 100 deployed against 5.0 at 300 million.
This article is one calculation from Raising a Real Estate Fund. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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